Natural Gas Just Cracked $5, Now What?

Two weeks ago, I warned that natural gas prices would benefit in the short term from frigid temperatures across the United States.

That’s exactly what happened.

As I write, we’ve seen a 25% jump in the price of gas since I released that article, marking the first time in four years that prices have broken the $5 level

For producers, $5 gas means monstrous profits – and a boon for an industry where profitability (in terms of retail prices) has languished for over four years.

However, they’d better enjoy the ride while they can, because this spike isn’t sustainable…

Super Spike Coming?

If you’re a longtime Oil & Energy Daily reader, you’ll know that I’ve predicted the current move in natural gas for a few years now and for the commodity to trade between $4 and $6 over the next three years.

Well, we’ve already seen the price eclipse our lower target – and we may even see $6 breached in the next few weeks.

According to my colleague, Lee Lowell, a former NYMEX trader, people in the futures markets are buying 30-day options with strike prices as high as $10 and $11.

While short-term spikes in any commodity are possible, we’re more interested in the longer-term picture…

Supplies Are Growing, Not Slowing

Even at $5, natural gas is historically cheap when compared to oil. In years past, the gas-to-oil ratio has topped out at around 10. In other words, crude oil trading at 10 times the price of natural gas.

The current price jump is simply a reaction to extreme weather creating a short-term supply problem.

But let’s be honest… there is no real supply shortage. If places like the Dakotas have enough gas to burn off massive quantities into the atmosphere, there’s no supply shortage!

The truth is, there’s ample gas in the system – and still more in the ground. Supply issues are linked to producers using older demand dynamics to predict usage – dynamics that don’t cut it when there’s a weather shock.

As the weather moderates, prices will fall as normal supply/demand dynamics take hold.

I’ve noted before that we can measure supply and demand (and future prices) by how many rigs are being deployed for natural gas and oil and liquids.

Over the past four years, natural gas rig counts haven’t nudged higher, as drillers couldn’t make money with prices below $4.

When those counts begin to increase, you’ll know that demand is a factor again.

Natural gas demand should be higher than it was a year or two ago. Utilities and consumers have been switching to it en masse, since it’s the cheapest form of energy (besides coal) on the market.

But what we’re seeing now is a demonstration of what the future holds for natural gas.

Within five years, demand will be strong enough and sustainable enough for prices to stay above $5 – and possibly above $6. And industry players will be rolling in money.

That makes companies like Encana (ECA) and Chesapeake Energy (CHK) terrific bets. They’re currently trading at or below levels that they traded at when natural gas was stuck in the $2s and $3s.

If you’re looking to play the future of natural gas, these two companies are a great start!

And “the chase” continues…

Karim Rahemtulla

With an expertise in emerging markets and energy, Karim Rahemtulla is regarded as one of the country's foremost resource and developing world analysts. Educated in England, Canada and the United States, Karim is fluent in several languages. His undergraduate studies were completed in Economics/Foreign Languages, and his graduate coursework was completed in Finance. Learn More >>

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